The Indian secular theme whose fortunes are tied to Indian housing market can look forward to interesting opportunities. The overall shift of the market in favour of organised player is an added tailwind for the listed entities.
However, given the premium valuation of most of the players, is it a space worth looking at?
The Indian wood panel industry is estimated to be around Rs285 bn. The industry has traditionally remained largely unorganised given the low technical know-how and skill set required in the sector. However, the pattern has gradually changed in the last few years as the organised players have grown at a much faster rate (12-15%) compared to industry growth rate of 5-7%, taking away the market share from unorganised entities. New construction activities (85-90%) drives most of the demand in the sector while the balance comes from renovation and replacement.
Plywood players shifting focus to MDF
Despite the industry being largely unorganised, the MDF (Medium Density Fibreboard) market in India is 100% organised as this segment poses an entry barrier in terms of high capital investments. MDF is increasingly being used as a substitute for low to medium quality plywood as it is 40-50% cheaper, resistant to moisture and can be easily moulded and machined for furniture applications.
There exists a significant scope for import substitution as 30-35% of the demand in India is met through imports. Additionally, anti-dumping duty of $64/CBM on import of MDF boards (with thickness 6 mm +) would further benefit the local players.
Aided by changing consumer preferences and government support, MDF is currently the fastest growing product in wood panel market. MDF demand is expected to grow at a CAGR of 14.1% to INR 31bn by FY21 from INR 16bn FY16.
The wood industry is dominated by four large players. The Plywood and MDF segment is dominated by Century Ply and Greenply which together constitute around 50% of the market. Likewise, Greenlam and Merino are the heavyweights in the laminate segment followed by Stylam and Rushil Décor. Amongst the big players, Merino Industries remains a private company while the rest are listed.
Industry players undertaking capex to tap future opportunities
The MDF segment being the fastest growing segment in plywood category, is getting the much needed attention from industry majors – Century Ply and Greenply.
Century Ply has recently forayed into the MDF segment while Greenply, which entered the MDF market in 2010, is in the process of tripling its MDF capacity. Rushil Décor is also building up on its strong presence in the wood furnishing space by adding new capacities in MDFs and WPCs (Wood Polymer Composite). The WPC product is environment friendly and is expected to grow at ~11% globally over the next five years. The WPC market in India is at nascent stage with penetration of just 1% as compared to high traction in Americas, Europe and China.
These incremental capacities would allow these companies to pick up revenue share from the low quality plywood suppliers which is fully unorganised. In addition to revenues and profits, the MDF vertical should also boost the return ratios of companies as it a high margin business (having RoCE of 24-25%).
Century Ply trades at an EV/Sales multiple of 4.2x on account of its market leadership position, high RoE (return on equity) and asset turnover. The operational efficiencies in its business execution results in a higher churn of its assets (asset turnover of 1.5x – 15-20% higher than peers) leading to higher operating margins and return ratios.
The asset turnover for the industry remains in the tight range of 1.2-1.5x and the return ratios remain healthy for all the players (upwards of 18%).
The sector remains rich in terms of valuations and takes into account the earnings expected on the back of recent capacity expansions. Government thrust on affordable housing, smart cities should result in buoyant demand for the sector. The rationalisation of GST rate (reduced from 28% to 18%), introduction of e-way bill and import substitution of MDF is envisaged to decisively shift demand as well as market share pendulum in favour of organised players.
With majority of the players increasing capacity at the same time, the industry could witness stiff competition and pricing pressure. Crude-linked chemicals and derivatives which form 20%-30% of the raw material costs could impact the margins of the players. These two factors need to be monitored closely. However, considering the overall demand-supply dynamics and execution capabilities, the listed player’s looks well positioned to post steady growth over the next couple of years.
Our preferred pick
Greenply remains our preferred pick in the sector considering the current valuations and revenue visibility. Greenply trades at a significant discount to Century as it lags behind in terms of operational efficiencies. The new capacity additions (MDF, laminates and decorative veneer) will boost volume growth in FY19 and FY20 and also aid improvement in net profit margins. We expect the capacity addition in MDF segment to be a big trigger for Greenply and expect its valuation gap with Century Ply to reduce over the coming 12-18 months as the company moves closer to the full commercialisation of its new capacities (expected Q2/Q3 FY19).
Rushil Décor seems to be best placed amongst the smaller players but its premium valuations leaves little room for comfort. The company is trying to build its brand and is also carving out a niche in mid to high segment products. The company’s recently commissioned WPC plant not only provides revenue visibility but also indicates its increasing focus on green and durable products which is sync with the market trends and consumer preferences.